With most of the action taking place elsewhere yesterday and news out of the UK sparse, sterling continued the trend of recent days by rallying 0.6% against the dollar on the retreat of financial stability concerns, whilst finishing flat against the euro as markets digested eurozone CPI readings. This morning, however, did see the release of house price data and revised Q4 GDP figures, both at 07:00 BST, giving UK focused investors something to chew on. Taken as a whole the data paints a mixed picture of the UK economy, with GDP growth being revised up, but house prices data coming in softer than expected. With Q4 GDP now showing 0.1% growth QoQ, and 0.6% YoY, it signifies a remarkable turnaround from just a few months ago, when all expectations were for the UK to fall into recession over the coming months on the back of a significant tightening in monetary conditions. In contrast, it appears to be house prices where the pain of higher interest rates are being felt, with Nationwide’s measure suggesting a fall of 0.8% in March, leaving them now down by 3.1% from the same time a year ago. This decline both exceeded expectations and marks an acceleration from the February numbers, a fact that will not go unnoticed at the Bank of England. Whilst a modest decline in house prices would likely be welcomed, especially as an alternative to a slowdown in GDP growth, policymakers will still be cognizant of the risks posed by a housing market meltdown. In our view, this reinforces the idea that the Bank has now reached the end of its hiking cycle. For the pound, this may theoretically be a negative outcome, however, it isn’t just higher interest rates that are now being favourably looked upon by markets, but also the longevity of them as pricing of monetary easing starts to appear in markets where overtightening looks more prominent.
It was all about flash inflation figures in the eurozone yesterday. After Germany’s most populous state, North Rhine Westphalia, posted a very early CPI reading of just 6.9% YoY for March, down from 8.5% in February, markets were eagerly awaiting some pleasant news for the ECB in the national figures. This expectation was further compounded by Spain’s headline inflation data at 08:00 BST, which almost halved from the month before as it fell 2.7 percentage points to 3.3%. However, as we had warned yesterday following the Spanish figures, drawing inferences for the ECB from the annual headline measure would be incorrect because of the large base effects that were at play. Instead, we expected markets to ultimately shift away from their early dovish reaction and instead zero in on the pace of monthly price gains and the core measures. This is ultimately what unfolded just an hour after the Spanish data was released. With price gains maintaining a rapid pace of 0.7% MoM and the core measure largely unchanged from the month before at 7.5% YoY, the market started to believe the ECB’s messaging that core inflation would keep it on track to continue hiking. This view was compounded shortly after US traders joined in on the fun as Germany’s national data pushed back on the softer regional readings to print 1.3pp lower at 7.4%. Again, more importantly, the pace of monthly price growth remained at an elevated 0.8% MoM, while best estimates of the core measure suggest it rose 0.2 percentage points on the month to 5.9% YoY. After finally interpreting the data in the correct manner, markets began to price in a much more hawkish ECB. Interest rate swaps implied 50bps worth of hikes from the central bank as early as Juy’s meeting, one meeting ahead of where they were placing such expectations a week ago. More hawkish interest rate expectations led the euro to record solid gains against the dollar as it closed 0.56% higher. At it’s current level, the single currency has not only retraced any SVB/ Credit Suisse related losses, but also the ground lost over the course of February when US data forced speculation of a higher terminal rate in the US and the potential for a reacceleration in the hiking cycle to 50bps.
This morning, inflation remains top-of-mind ahead of the eurozone composite CPI reading at 10:00 BST, but the signal for markets was likely already delivered yesterday. This is best evidenced by the absent market reaction to French inflation data, which was released at 07:45 BST and showed the headline figure fell 0.9pp at 5.6% YoY and 0.2pp at 0.8% MoM in March. Again, progress in the annual figure is undermined by the fact that the pace of overall price gains remains uncomfortably high. Today, within the eurozone-wide measure, we will get a reading on overall core inflation. Estimates are for a slight uptick to 5.7% YoY, however, recent data suggests this is now too conservative. Should core inflation accelerate towards 6%, we expect markets to fully price in a 25bp hike from the ECB at their May meeting, up from just 80% priced in currently, while expectations of the terminal rate are likely to drift closer to 3.75%. This should, all things considered, help EURUSD retrace back towards its year-to-date high in due course.
After benefiting from early rebalancing flows mid-week, the dollar resumed trading on the back foot yesterday as the DXY index fell 0.46% to an eight week low just north of 102. The decline in the dollar corresponded with a marginal uptick in expectations of the Fed with a 25bp hike at the May 3rd meeting now 62% priced into swap markets. However, more hawkish pricing of US interest rates no longer holds the gravity that it once did in FX markets, mainly because money market traders are still assuming an early adoption of policy easing shortly afterwards. Pricing of rate cuts wasn’t appeased yesterday either as FOMC members continued to stress that they have no estimate of how much credit conditions have effectively tightened monetary policy following the fallout in the regional banking sector. Signs that the Fed is no longer in control of the effective interest rate for the real economy doesn’t invite confidence and only entrenches expectations that an easing of policy is the likeliest option heading into the second half of the year should a credit crunch become more visible. For now, the health of the US banking sector remains a peripheral concern, aided by the release of the Fed’s balance sheet data yesterday which showed a decline in the amount of outstanding borrowing in the week up until March 29th.
Today, emphasis is going to remain on the Fed’s balance sheet data with the release of data on commercial bank assets and liabilities for the week up until March 22nd. The data should, therefore, show the state of the commercial banks deposits in the week after the SVB collapse. Outside of that, markets will also hear from Fed members John Williams and Lisa Cook today, with Williams likely to be the more interesting of the two seeing as his is yet to chime into the recent debate. In addition, PCE data for March is released at 13:30 BST, but as one might expect, this is unlikely to prove influential for markets seeing as attention is firmly elsewhere.
The Canadian dollar continued its rally on Thursday, supported by still-bullish equities and a rise in crude oil to the $74 handle. With the fourth consecutive gain making this the longest win streak in 6 months, the currency is now at its strongest level against the dollar in 5 weeks. For the most part, news flow remained minimal, but no news is good news when the most recent major stories inflamed fears that the global financial system could blow up. Perhaps the most important news story for Canada was that the Canada Mortgage and Housing Corporation has announced a housing accelerator fund. This is an incentive scheme that will pay municipal governments if they agree to ramp up the pace of housing construction. It’s a much-needed program, as zoning laws have severely constrained the supply of housing in Canada, and the recent announcement of a much larger immigration target is bound to increase housing demand. Today, we will get GDP data for Canada at 08:30 EST (13:30 BST). The consensus has pencilled in a 0.4% MoM and 2.9% YoY print for January, which marks an acceleration from December.